Mortgage Rates Plunge as Fed Signals Potential September Rate Cut

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The bond market has been buoyed by the Federal Reserve's recent hints that a rate cut may be on the horizon this September, leading to a noticeable drop in mortgage rates. Investors are reacting to the Fed's subtle language changes, anticipating a potential shift in monetary policy.

In its latest meeting, the Federal Open Market Committee (FOMC) decided to keep the short-term federal funds rate unchanged at 5.25% to 5.50%. However, the Fed's statement reflected a shift in tone. According to Ian Shepherdson, Chief Economist at Pantheon Macroeconomics, the Fed upgraded its assessment of inflation from "modest" to "some" progress towards its 2% target. Inflation is now described as "somewhat" elevated, with risks to both inflation and employment appearing more balanced (Shepherdson, 2024).

Fed Chair Jerome Powell echoed these sentiments, indicating a readiness to adjust rates if economic conditions necessitate it. “We know that reducing policy restraint too soon or too much could result in a reversal of the progress that we’ve seen on inflation,” Powell stated. “Conversely, reducing policy restraint too late or too little could weaken economic activity and employment” (Powell, 2024).

The bond market’s reaction has been swift. Investors expect at least a 25 basis point cut in September, with an 18% chance of a more aggressive 50 basis point reduction. Futures market bets suggest a 75% chance of a 75 basis point cut by year-end, a significant increase from prior predictions (CME FedWatch Tool, 2024).

Mortgage rates have already started reflecting these expectations. As of Tuesday, the average rate for a 30-year fixed-rate conforming mortgage dropped to 6.71%, down 30 basis points from July 1 and a substantial decrease from the 2024 peak of 7.27% (Optimal Blue, 2024). In contrast, jumbo mortgage rates, which are not as responsive to Fed actions, averaged 7.22%, showing only a modest reduction (Optimal Blue, 2024).

Economic analysts forecast that conforming mortgage rates could continue their descent, potentially reaching the low sixes by the end of next year (Fannie Mae & MBA, 2024). Despite these promising trends, the response from homebuyers has been tepid. The Mortgage Bankers Association (MBA) reports a 2% decline in purchase loan applications week-over-week, and a 14% drop compared to last year. Refinancing applications also saw a 7% week-over-week decrease, though they were up 32% year-over-year (MBA, 2024).

While the prospect of lower mortgage rates is encouraging, the path to increased mortgage origination volumes may be slow. Fitch Ratings' Senior Director Eric Orenstein notes that high home prices and existing low mortgage rates are still significant hurdles for the housing market (Orenstein, 2024).

As the Fed’s potential rate cut approaches, the market will be watching closely to see if these trends continue and whether they will stimulate a more robust response from homebuyers.